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Ride This Bull Market

The world hadn't experienced a financial meltdown this awful since the 1930s. Because of huge government and consumer debt burdens, plus continuing problems in the financial system, the recovery will certainly be anemic. The U.S. stock market -- up more than 50% from its low -- is no longer cheap.

But the big-picture thinkers I trust most say the bull market is far from over. Yes, I mean "bull market." People are so negative on stocks that few label the current advance a bull market. But what else do you call it when Standard & Poor's 500-stock index surges 52% in less than six months?

Widespread pessimism is actually a bullish sign. It means other investors are wary of stocks. Indeed, $3.6 trillion is currently parked in money-market mutual funds-even though they yield virtually nothing. That's a lot of fuel to lift the market higher. The Federal Reserve Board's easy monetary policy is also bullish for stocks.

But don't take my word for it. Listen to Steve Leuthold, who heads the Leuthold Group, a Minneapolis-based research firm. Or to Jim Stack, a money manager and newsletter writer who turned bullish soon after the market's March 9 bottom (see Time to Say Goodbye to the Bear?). Both are savvy veterans.

Leuthold tracks 190 indicators, which measure everything from how cheap or expensive the market is to the level of pessimism or optimism among investors. He also studies economic conditions.

As a group, the indicators are currently more bullish than they have been at any time since 1989 -- except for a month ago. Leuthold says the S&P 500 will likely rise to 1200 by year-end, a gain of almost 20% from its August 31 close of 1021. "We're not looking for a robust recovery," says Andy Engel, Leuthold's senior research analyst. "But we should get good-size stock returns over the next six to 12 months."

Stack, president of InvesTech Research in Whitefish, Mont., comes to nearly the same conclusion. "Virtually all the technical blocks are in place for a bull market," he wrote recently. "Unless the technical backdrop changes, we expect the market to continue to work its way higher with the potential for solid double-digit gains over the next six to nine months."

Neither Leuthold nor Stack sees an imminent return of the "good old days" of the 1980s and 1990s -- when stocks soared an annualized 18%. Nor do I. But that doesn't mean you won't make money in stocks.

Want some other reasons the market should keep rising? They're numerous. Whenever we've had a horrible decade, the market has produced terrific returns in subsequent years. And while the economic recovery will be subdued, corporate earnings will jump compared with their depressed levels of the first half of this year. Finally, although the stock market isn't cheap, it isn't expensive, either. Leuthold says price-earnings ratios are at about their 135-year average. "The dirty secret is that the stock market almost never trades near median or 'fair' valuations, but tends to spend years-sometimes decades-to one side or the other of the median," according to Leuthold's monthly report.

Still, the bull market may not last long. Leuthold is concerned about the economy. Government intervention, particularly by the Federal Reserve Board, was necessary to stave off disaster, says Engel, the Leuthold analyst. But he worries about the Fed's exit strategy. Unless the Fed times its withdrawal perfectly, the nation probably will either fall back into a recession or see a marked increase in the inflation rate. Stack worries, too, about inflation and the vulnerability of the dollar "12 to 18 months down the road."

I see two ways investors can deal with those problems. You can take 10% or 15% or your money out of the market when things begin to look bleak again-that is, attempt to time the market.

But I wouldn't go overboard -- market timing is devilishly tricky. I'll be the first to admit that what you're reading here amounts to little more than a best guess. No one really knows which way the market will head, particularly over the short and intermediate term. Neither Leuthold nor I foresaw last September's market plunge, although Stack did call it.

The other way to prepare for hard times is to invest the lion's share of your stock money in the market's strongest companies. Even though high-quality, large-company growth stocks have led the market so far this year, most are still cheap relative to earnings, sales and assets. These blue chips typically sport strong balance sheets, feature powerful franchises and derive a significant amount of their business overseas-all characteristics that should help the companies do well under most economic conditions.

My longtime favorite fund in this area, Vanguard Primecap Core (symbol VPCCX), recently closed to new investors and restricted investments by existing shareholders. But Primecap Odyssey Growth (POGRX) is run by the same management team that is in charge of the Vanguard fund and is, in fact, almost identical to the Vanguard fund. Odyssey Growth's expenses, at 0.71% a year, are slightly higher than the Vanguard fund's yearly fees of 0.50%. Another good choice is Fidelity Contrafund (FCNTX), managed by Will Danoff. Its expenses are 0.94%. (Both Vanguard Primecap Core and Contrafund are members of the Kiplinger 25.)

The other area to emphasize is emerging markets. Unlike the developed world, many emerging nations have healthy balance sheets and growing economies. My favorite funds are T. Rowe Price Emerging Markets (PRMSX), SSgA Emerging Markets (SSEMX) and Vanguard Emerging Markets Stock Index (VEIEX). I wrote about these recently (see Is It too Late to Buy Emerging Markets).